When disaster hits, one immediate challenge is to return to normal business operations. Your tenants and your employees rely on it for their livelihood. While Hurricane Sandy is an extreme example, even much less severe events can impact the business.
When a building or business personal property is damaged, the resulting financial loss is not limited to the physical damage to the property. The loss of income the business suffers can often be greater than the monetary loss caused by the damage to the property itself. Just as individuals need disability insurance to protect themselves from the loss of personal income suffered because of an accident or illness, so a commercial property needs business income insurance to replace the income lost following serious damage to property. Although this type of insurance may be included in other types of policies, such as equipment breakdown or computer insurance, it must be considered separately.
Business income insurance, often called business interruption insurance, or sometimes loss of income insurance, enables a firm to protect itself against the loss of income suffered as a result of direct physical damage to insured property. One common example includes losses suffered by property owners and managers when serious property damage prevents them from collecting rental income. For example, a fire, collapse, or explosion could damage a building to such a degree that the tenants would be able to cease paying rent temporarily because they could not occupy the premises or, if the damage were serious enough, to cancel their leases altogether. Business income insurance would cover net income plus continuing expenses from the date of the loss to the time that the building should be repaired, rebuilt, or replaced with reasonable speed and similar quality construction. In addition, business income insurance covers expenses that are necessarily incurred to reduce the loss of income.
One of the most important considerations in the purchase of business income insurance is the determination of how much coverage is needed. A loss could occur any time during the policy period, and the loss period could extend for many months beyond the expiration of the policy period. In considering the amount of business income coverage to purchase, you must assume that the loss will occur at that point in the policy period in which the financial loss will be the greatest and will continue for the longest reasonable period of time it would take to repair the worst possible damage.
The business income policy does not have a time limitation under which you can collect the loss of income other than the time reasonably necessary to repair or replace the damage. Any recovery under this coverage is only limited by the amount of insurance you buy. In contrast, under the typical BOP (business owners policy), the recovery for loss of income is provided for the actual loss sustained (no dollar amount limitation), but for only the 12-month period following an insured loss.
The following special types of insurance protect against other forms of income loss.
Many types of businesses cannot afford to be shut down, even if their loss of income is insured during the period of reconstruction or repair. The physical facilities in which they operate are not as important as their ability to continue serving their customers. Most of these businesses would be classified as service businesses, and they are prime candidates for including extra-expense protection into their business income insurance coverage.
Extra-expense insurance pays the necessary additional expenses the insured incurs during a period of restoration that the insured would not have incurred if there had been no direct physical loss or damage. In other words, the coverage pays for such expenses as overtime pay to regular employees for the extra hours worked, the extra expense of renting suitable temporary space, and the cost to ship replacement equipment on an emergency basis.
Contingent Business Income Insurance
In many situations, businesses depend greatly on selling to one or more large customers or on buying from one or more large suppliers. If such a customer or supplier incurs severe damage as a result of an insurable loss, the business that depends on it for economic survival could be financially damaged as well. That business can purchase contingent business income insurance to protect itself from financial loss resulting from certain damage occurring at the principal customer’s or supplier’s premises. This situation can also exist in a shopping center in which smaller tenants depend on the anchor tenant in the center to help them draw customers to their own businesses.
Accounts Receivable Insurance
Many businesses bill their customers and give them a certain time to pay the bill. If a business’ records of those accounts receivable were damaged or destroyed, many customers might not pay their bills. Accounts receivable insurance indemnifies businesses for their financial losses when they are unable to collect money owed because of physical damage or destruction to accounts receivable records. It also pays the expense of reconstructing those records. This coverage can be included in computer insurance if the records are kept on computers.
It is important to note that the scope of accounts receivable insurance does not cover any losses due to bad debt.
Leasehold Interest Insurance
Landlords or tenants often have an insurable interest in protecting themselves from an exposure to financial loss that is related to the terms of the lease. For example, a landlord may have an especially advantageous lease that it could not duplicate if the tenant were to cancel it due to a severe loss, such as a fire or explosion. A tenant may also have an advantageous lease situation in which it would have to pay a much higher rent in the open market than the rent it is currently paying. In the event of a serious loss, the landlord might be able, under the terms of the lease, to cancel the tenant’s lease and find another tenant to pay rent at the current higher market rate for that space.
Both the landlord and, more commonly, the tenant may protect themselves from this loss exposure through the purchase of leasehold interest insurance. Basically, they would calculate the differential between the current rental rate and the market rate for the space, and then insure the difference for the remaining unexpired term of the lease. They would determine the discounted present value of that dollar figure to ascertain the total amount of the leasehold interest insurance needed.
If you have not done so recently, it is useful to review what insurance protections you have to help you recover from loss of business as a result of damage to your facility.
More information on this topic is available from the BOMI International course Law and Risk Management, part of the RPA® designation program. For more information regarding this course and BOMI International’s education programs, call 800-235-2664. Visit BOMI International’s website, www.bomi.org.